Where Is Dr. Paul’s Inflation?

A recent Reason Magazine article asks the question “where is Dr. Paul’s inflation?” – In which the author insinuates that inflation hasn’t reared its ugly head by citing Professor Mark Perry’s take on the latest CPI report.

Perry writes:

Bottom Line: Compared to last summer for the three and six month periods ending in July 2011, inflationary pressures fell significantly towards the end of last year and in the first month of 2012 for the three and six month periods ending in January.  Inflation for food at home has fallen to only 1% (at an annual rate) for the November-January period.

While this is true if you assume government inflation statistics are correct, I would argue that the CPI report is about as accurate as a quadriplegic sniper on horseback.

Looking at inflation rates as calculated using the 1990s model of the CPI, inflation is hovering around 6.5%.  If we use the same model the government used during the 1980s, inflation is around 11%.   The government continually adjusts its CPI models to prevent high inflation numbers from showing up in its reports by using hedonics and other statistical tom-foolery.  If government actually reported the real rate of inflation, it would drive itself into bankruptcy at lightning speed because social security payments are adjusted by the CPI metric.

But putting that aside, the original question is still somewhat valid.  Why isn’t the US experiencing hyper-inflationary rates that even the heavily manipulated bogus CPI reports can’t hide?

The answer lies in how new money actually enters economic circulation.  Bernanke has printed trillions of dollars in new reserve capital and is single handedly preventing the bankruptcy of Wall Street with his monetary policy.  However, not much of this new reserve capital that Bernanke has printed is actually making its way into the hands of consumers.  Right now, the banks are sitting on it all because they are essentially being paid not to lend it out.

By sitting on all that bailout money and keeping it at the Fed, the banks are slowly re-capitalizing themselves by earning interest on the money they have parked with the Fed.  This is a no-risk way for the banks to make billions in order to fill up their bankrupted reserves.  Inflation rates will increase once those banks begin lowering interest rates for consumers and start lending out all that money they have parked at the Fed.

In reality, we already got hit with the inflationary bomb.   The housing boom, and its associated inflation, was (past tense) a severe inflationary episode (which was hidden by bogus CPI manipulations).  Bernanke and Greenspan artificially pushed down rates during the boom years which caused a massive credit expansion.  Vast sums of new money (which is nothing more than new debt) was pumped into the economy during the housing boom because banks were able to lend at extremely low rates.  When consumers took out new home loans, what they were really doing was expanding the amount of dollars in circulation.  The more debt, the more money in circulation.  That is how our corrupt system works.

So what we experienced in 2007 was a collapse of this Ponzi, where by defaults wiped out the supply of money.  Since more debt means more money in circulation, when debtors default the exact opposite occurs, we experience deflation, a reduction in the amount of money in circulation.

Bernanke managed to halt the deflation by preventing bankruptcies.  He stopped the all the major banks from going bankrupt by handing the banks trillions in bailout money.  As individual homeowners went bankrupt, Bernanke simply handed the banks money to make up for their losses.  Had those banks gone bankrupt, we would have experienced massive deflation, a reduction in the amount of money in circulation.  Interest rates would have skyrocketed and new loan issuance would have plummeted.

So here are today with the inflation rates sitting relatively flat in comparison to the vast sums of money that were printed and handed to banks.  But really when you look at the way our financial system operates it makes perfect sense.  Consumer inflation (what we see in the CPI), already occurred during the boom phase as this was the period of consumer credit expansion.  All Bernanke did with his epic bailouts was keep the money supply at its current levels.  The rate of inflation will start increasing once again as banks finish recapitalizing themselves and begin to lend all that money out.  Bernanke can’t keep paying the banks not to lend forever or the bank reserves will eventually reach titanic proportions (interest compounds ya know).

Now let us move on to the argument Ron Paul is making.  We must remember that it is real goods and services that give money its value.  If people stop accepting a given money in exchange for real goods and services, the money loses its value rapidly.

Consider this:

China and Japan are some of our largest creditors.  They buy US Treasury debt, and in exchange, the Treasury gets dollars to spend.  China is basically financing our purchasing of their products!  This is like Ford financing credit for people to buy its cars.  This is all fine and good until the creditors start realizing that the people they are lending to are paying them back with money that is worth less than the value of the loan.

Would Ford keep lending money to people if it knew that it was a losing proposition?  Would Ford keep lending if the interest it was earning on its loans was so far below the rate of real inflation that it was losing money on the deal?  Of course not.  Ford would demand higher rates or it would quit lending money.  Further, Ford would probably try to unload its current loans on to some other creditor who is dumb enough to buy them.

This is the situation we are rapidly approaching today.  If China and Japan were to come to the conclusion that the Treasury debt they are holding isn’t keeping up with the rate of inflation, they may sell off that debt in an attempt to cut their loses.   Should this occur, the dollar’s value would plummet overnight.  All imported goods would become wildly expensive as the people who actually make the goods would start demanding real goods in exchange for real goods.  In other words, China might say, “hey, I have some really nice toasters over here, but if you want some of these toasters, you need to give me some machine tools first.  I’m not going to sell them to you for dollars that you ran off a printing press.” – which is why the gold standard played such an important role as a money.  Gold is a real tangible product that can’t be run off a printing press.  This is exactly the situation Greece is facing today.  

No one wants to sell the Greeks anything because they know they will not get anything of value in return.  If Greece were to get kicked out of the Euro and start its own currency, its own currency would be worth next to nothing as far as foreign countries are concerned because the Greek economy doesn’t produce anything of value.  It’s just a bunch of socialist government workers who don’t actually produce anything of trade value.

This brings us full circle back to America’s pending financial implosion.  The problem isn’t so much that Bernanke printed all this money to keep his crony-capitalist banker buddies solvent (although that is certainly an epic problem).  The implosion of the dollar will arise from the fact that government is issuing trillions upon trillions of new public debt, and its using that debt to finance all of its wars and social programs.

These unproductive government jobs include the entire defense industry since F-18 fighter jets aren’t worth a hill of beans to your average Chinese consumer.  Likewise for all the make-work projects and crony-capitalist boondoggles like the Solyndra scandal.  Government can create all the jobs it wants and spend all the money it wants, but when it does so, it prevents those resources from being used by the private sector to make things that actually have market value.

If government prints up a hundred billion for a new aircraft carrier, think of all the steel and manpower that is taken out of the private markets!  The price of steel for automakers will have to increase substantially because so much steel has been diverted into the production of a carrier.  While the automakers have to buy their steel using the profits they earn from market sales, the government doesn’t have any such limits.  It can buy all the steel it wants because it can print all the money it wants.

The fact that public debt is increasing at near parabolic rates is due to the fact that the private economy is so damaged from all the government spending that it can’t make enough real goods and services in quantities large enough to generate tax revenues at rates that would allow the government to balance its books.  Government is forced to print money to fiance its profligate spending because it can’t tax the real economy enough to keep up with its spending!

Since the real economy is so damaged and produces so few things of trade value, eventually there will come a point where the rest of the world simply rejects the dollar.  People will start demanding yuan or rubles or gold or anything else they think will actually be worth something in trade.  People will start demanding massive interest rates from the government before they are willing to purchase more government debt.  We see this plain as day in Greece at the moment.  Take a look at Greek bond yields over just the past few months:

 This will happen here, and it will happen for the exact same reasons!

So to sum up my answer to Reason’s question, we aren’t experiencing rapid hyper-inflation yet because people still have confidence in the dollar.  When that confidence finally comes to an end, as it just did for Greece, then we will see the type of hyper-inflation Dr. Paul is warning us about.

We have already experienced massive inflation in comparison to when this nation was on a gold standard.  But as Dr. Paul points out, by comparison the inflation of today will look like a joke compared to what is eventually going to happen.

  • Jkduhf

    “Right now, the banks are sitting on it all because they are essentially being paid not to lend it out.”

    Absolutely true

    If you tried borrow money lately you will know, only thing missing from required documentation is a sperm sample.

  • Rom

    The pension funds have to park their investments somewhere until they are in balance, that is until the number of dead pensions more or less balance the new recruits joining the fund.
    Suddenly the fund need very few government bonds except to replace those that have expired at therefore paid back in cash.
    The governments have spent the savings of the people reserved for their old age, well knowing that they could never keep their promises to refund the pension funds.

  • Eric

    The housing boom was a bubble, not inflation, although the two are related.

    When a central bank creates enormous amounts of money and channels it into a very few homogenous pockets, they are going to be looking at places to invest the money and much of it will largely end up in the same kinds of investments.  This will create a bubble, not inflation.

    The result will be inflation if the enormous amounts of money created is spread around more haphazardly and isn’t concentrated in a chosen few.

    The money created by the Federal Reserve in their effort to make the crash of the Dot Com Bubble less painful for their wealthy and influential friends largely ended up going to housing securities.  The natural result was a housing bubble, not a general inflation.

    • When the central bank artificially lowers rates, it will produce inflation.  Prices are not stable.  They rise over time.  You are wrong in your assessment.  If you were right, then there would be no inflation.